Does Debt Consolidation Hurt Your Credit?

Consolidating debts into one payment that's easier to handle can help your credit and budget, but there are risks.
Bev O'SheaOct 13, 2021

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Consolidating your debt can lower your monthly payments, but it can also cause a temporary dip in your credit score. Two common debt consolidation approaches are getting a debt consolidation loan or a balance transfer card.

Any credit application typically triggers a hard inquiry on your credit, which can lower your credit score by a few points for a few months. But the overall credit effect of debt consolidation should be positive, if you make sure to pay on time and change the habits that led debt to stack up.

Here’s a closer look at the potential impact on your credit when you consolidate debt with a personal loan or balance transfer credit card, plus some other debt consolidation options.

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How debt consolidation can affect your credit

Debt consolidation combines several debts into one, ideally with a lower interest rate.

Having fewer payments to juggle helps with budgeting. And cutting the interest rate can help you pay off debt faster, because more of your payment goes toward the debt rather than the interest.

Consolidating debt with a personal loan

Pros:

  • Generally requires a lower credit score for approval than a balance transfer card. (Not sure where you stand? Check your free credit score with NerdWallet.)

  • Can help improve your credit mix if you had only credit cards, because it is an installment loan.

  • Can combine several payments into one, simplifying your finances.

  • Can improve credit by lowering the amount of your credit limits you're using, if you move credit card balances to an installment loan.

Cons:

  • It can lead to even more debt if you use up the newly available space on credit cards.

  • If you end up overextended and unable to pay, missed payments will damage your credit.

  • You may pay high fees to borrow money unless you understand the APR.

  • The loan may have a prepayment penalty, locking you into a fixed payment period.

Consolidating debt with a balance transfer card

Pros:

  • You may be able to get a lower interest rate (often for a set time), including a 0% APR for excellent credit consumers.

  • Payments are more flexible than with a loan.

  • No prepayment penalty.

Cons:

  • Your score may initially fall because of high credit utilization if you use a lot of the new card's credit limit.

  • You may owe interest if you don't pay off the debt before the introductory rate runs out.

Other options for debt consolidation

If those options don’t seem like a good fit, there are other debt consolidation options. These also can affect your credit.

Keep in mind it’s generally not a good idea to replace unsecured debt (like credit card debt) with secured debt (like a mortgage or car loan) because you could lose your home or vehicle if you can’t pay.

  • Home equity loan or line of credit: This will be reported either as an installment loan or revolving account, depending on which loan type you get. You’ll also get hit with a credit check.

  • Debt management plan: Seeing a credit counselor and signing up for a debt management plan does not directly affect your credit score, but negotiating to pay less than the full amount due or closing credit cards can hurt your score. A DMP is noted on your credit report while it is in effect, but not after the plan is completed.

  • 401(k) loan: This does not appear on your credit report, so it has no effect on your credit score. But you're costing yourself investment returns, and the effect grows over time. This is best as a last resort.